The Master Lease Option Series – Part 2: Keep Them SeparatedPosted on April 4, 2016 by
I mentioned in the last article of this series that a master lease option (MLO) agreement is made of two separate documents. The two documents are the master lease and the option to purchase (also called an option memorandum). The separation is for many reasons, which I will cover in this article. Keeping them separated allows for more freedom and safety on your side of the deal.
The first half of the agreement is the master lease. The lease allows us to control the operations of the property. This means that if you find a deal that is distressed due to something the owner has done or not done then you can remedy those issues by controlling the daily operations with the lease. Note that I mentioned the distress coming from the owners operations. I make this remark because sometimes properties are in areas or neighborhoods that naturally have high vacancy or will be difficult to operate in general. A lease option is for fixing distressed deals not distressed neighborhoods. Make sure that a distressed asset is in a valuable area and has been mismanaged. These are the “MLO gold” that we are all looking for.
Once you have analyzed a deal and realize that better managers could do a better job… you are on the right path. The lease will allow you to hire a new management company or it will allow you to manage it better yourself. By keeping this document separate you are keeping the cash flow separated from the sale of the deal. Cash flow is a very valuable part of a lease option. The lease portion allows us to control and keep the cash generated by the asset. You will owe the seller a “rent” payment each month but anything above that is yours to keep!
Now that you see how the cash flow can be generated and kept through better management I will explain why you want this document separate. You can sell it! You can sell the lease portion of the MLO and still keep the right to buy it in the future. The value of the lease will be largely based on the cash flow it produces. It’s a stream of income. Do you know anyone who wants multiple streams of income? I do. Those people would be candidates for purchasing the lease from you so they can collect the monthly revenue and that would give you an instant chuck of cash for your efforts. The more cash flow the more valuable the lease and the more you can sell it for.
Now let’s discuss the second half of the MLO. This is the option to purchase, which gives us the ability to set the purchase price today with the right to buy the property at a future point in time (at that price). The basic formula here is to find distressed assets in a good area and fix them up by stabilizing the operations. Once you do this the property will undoubtedly be worth more than before the rehab/stabilization of it. If you analyzed the deal correctly and negotiated properly then you should have set the option price to reflect the value of the property in its distressed state. Now that you have the property up and running better, you have a set price that is less than its current value but you still have the right to buy it at its previous value (the option price). At this point you will have a price that is lower than the new value…you can sell it! You can sell the option to purchase just like you can sell the lease. You can sell the right to buy the property at a future date for less than it’s currently worth. Sounds like wholesaling to me! With this new technique you can sell properties that you never owned just like wholesaling but the best part is you can actually fix up the place before you sell the option to purchase and force the value up which will get the best price for your option document.
There is one last reason to keep your lease separate from your option to purchase and that is for legal reasons. I am not an attorney and I am not offering you legal advice here but if you ever have to deal with a legal dispute over your MLO its best to be able to deal with them separately. Always have an attorney create your documents and review any before you offer them to a seller.
Now you see why doing MLO deals is a great way to make cash flow as well as create chunks of cash without ever buying the property. It’s wholesaling on steroids! Keeping the documents separate allows you to pick and choose what to sell and what to keep or you can sell the both at the same time. The choice is yours!
Good luck out there!